**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

**FORM10-QSB**

**QuarterlyReport Under Section 13 or 15(d) of the Securities Exchange Act of 1934**

**For thequarterly period ended July 31, 2006**

**CommissionFile No. 1-8125**

**TOROTEL, INC.**

(Exact name ofsmall business issuer as specified in its charter)
| **MISSOURI**                     | ** ** | **44-0610086**                        |
|----------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  |       |                                  |

 

**620 NORTH LINDENWOOD DRIVE,OLATHE, KANSAS  66062**

(Address ofprincipal executive offices)

**(913) 747-6111**

(Issuer’stelephone number)

**NONE**

(Former name,former address and former fiscal year, if changed since last report)

Check whether theissuer (1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months and (2) has been subject to such filingrequirements for the past 90 days.

Yes x   No o

Check whether the issuer(1) filed all reports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months and (2) has been subject to such filingrequirements for the past 90 days.

Yes x   No o

Check whether the issueris a shell company (as defined in Rule 12b-2 of the Exchange Act.)

Yes o   No x

As of September 8, 2006, there were 5,311,590 shares of Common Stock,$.01 par value, outstanding.

 

 

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TOROTEL, INC. ANDSUBSIDIARIES

INDEX
| PART I.  FINANCIAL INFORMATION                                                       |                                                            |
|-------------------------------------------------------------------------------------------|-----------------------------------------------------------------|
|                                                                                      |                                                            |
| Item 1.                                                                                   | Financial  Statements                                           |   |
|                                                                                      |                                                            |   |
| Consolidated Balance Sheet as of July  31, 2006                                           |                                                            |
|                                                                                      |                                                            |
| Consolidated Statements of  Operations for the three months  ended July 31, 2006 and 2005 |                                                            |
|                                                                                      |                                                            |
| Consolidated Statements of  Cash Flows for the three months  ended July 31, 2006 and 2005 |                                                            |
|                                                                                      |                                                            |
| Notes to Consolidated  Financial Statements                                               |                                                            |
|                                                                                      |                                                            |
| Item 2.                                                                                   | Management’s  Discussion and Analysis or Plan of Operation |   |
|                                                                                      |                                                            |   |
| Item 3.                                                                                   | Controls  and Procedures                                        |   |
|                                                                                      |                                                            |   |
| PART  II.  OTHER INFORMATION                                                         |                                                            |
|                                                                                      |                                                            |
| Item 6.                                                                                   | Exhibits  and Reports on Form 8-K                               |   |
|                                                                                      |                                                            |   |
| SIGNATURES                                                                                |                                                            |

 

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PART I.  FINANCIAL INFORMATION

Item 1.    Financial Statements

CONSOLIDATED BALANCESHEET (Unaudited)

As of July 31, 2006
| ASSETS                                            |   |      |      |
|---------------------------------------------------|--------|-----------|-----------|
|                                              |   |      |      |
| Current assets:                                   |   |      |      |
| Cash                                              |   | $         | 621,000   |   |
| Accounts  receivable, net                         |   | 554,000   |      |
| Inventories                                       |   | 313,000   |      |
| Prepaid expenses  and other current assets        |   | 60,000    |      |
|                                              |   | 1,548,000 |      |
|                                              |   |      |      |
| Property, plant and  equipment, net               |   | 1,057,000 |      |
|                                              |   |      |      |
| Intangible assets, net                            |   | 684,000   |      |
| Other assets                                      |   | 4,000     |      |
| Equity investment                                 |   | —    |      |
|                                              |   |      |      |
|                                              |   | $         | 3,293,000 |   |
|                                              |   |      |      |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY        |   |      |      |
|                                              |   |      |      |
| Current liabilities:                              |   |      |      |
| Current  maturities of long-term debt             |   | $         | 55,000    |   |
| Note payable to  shareholders                     |   | 750,000   |      |
| Trade accounts  payable                           |   | 244,000   |      |
| Accrued  liabilities                              |   | 209,000   |      |
| Accrued interest  on note payable to shareholders |   | 5,000     |      |
|                                              |   | 1,263,000 |      |
|                                              |   |      |      |
| Long-term debt, less  current maturities          |   | 756,000   |      |
|                                              |   |      |      |
| Stockholders’ equity                         |   | 1,274,000 |      |
|                                              |   |      |      |
|                                              |   | $         | 3,293,000 |   |

 

The accompanyingnotes are an integral part of this statement.

1

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CONSOLIDATED STATEMENTSOF OPERATIONS (Unaudited)

Three Months Ended July31,
| ** **                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net sales                                                                                                  |       | $        | 1,199,000  |     | $          | 1,267,000 |   |
| Cost of goods  sold                                                                                        |       | 801,000  |       | 718,000  |       |
|                                                                                                       |       |     |       |     |       |
| Gross profit                                                                                               |       | 398,000  |       | 549,000  |       |
|                                                                                                       |       |     |       |     |       |
| Operating  expenses:                                                                                       |       |     |       |     |       |
| Engineering                                                                                                |       | 64,000   |       | 57,000   |       |
| Selling, general and administrative                                                                        |       | 446,000  |       | 355,000  |       |
| Amortization of intangible assets                                                                          |       | 7,000    |       | 16,000   |       |
|                                                                                                       |       | 517,000  |       | 428,000  |       |
|                                                                                                       |       |     |       |     |       |
| Earnings (loss) from operations                                                                            |       | (119,000 | )          | 121,000  |       |
|                                                                                                       |       |     |       |     |       |
| Other expense  (income):                                                                                   |       |     |       |     |       |
| Interest expense                                                                                           |       | 27,000   |       | 33,000   |       |
| Interest income                                                                                            |       | (2,000   | )          | —   |       |
| Impairment of real estate                                                                                  |       | —   |       | 36,000   |       |
| Gain on settlement of debt                                                                                 |       | —   |       | (35,000  | )          |
| Gain on sale of real estate                                                                                |       | —   |       | (105,000 | )          |
|                                                                                                       |       | 25,000   |       | (71,000  | )          |
|                                                                                                       |       |     |       |     |       |
| Earnings (loss) before provision for income taxes  and cumulative effect of change in accounting principle |       | (144,000 | )          | 192,000  |       |
|                                                                                                       |       |     |       |     |       |
| Provision for  income taxes                                                                                |       | —   |       | —   |       |
|                                                                                                       |       |     |       |     |       |
| Earnings (loss) before cumulative effect of change  in accounting principle                                |       | (144,000 | )          | 192,000  |       |
|                                                                                                       |       |     |       |     |       |
| Cumulative  effect of change in accounting principle                                                       |       | 8,000    |       | —   |       |
|                                                                                                       |       |     |       |     |       |
| Net earnings  (loss)                                                                                       |       | $        | (136,000   | )        | $          | 192,000 |   |
|                                                                                                       |       |     |       |     |       |
| Basic earnings  (loss) per share:                                                                          |       |     |       |     |       |
| Before cumulative effect                                                                                   |       | $        | (.03       | )        | $          | .04 |   |
| Cumulative effect                                                                                          |       | —   |       | —   |       |
|                                                                                                       |       | $        | (.03       | )        | $          | .04 |   |
| Diluted earnings  (loss) per share:                                                                        |       |     |       |     |       |
| Before cumulative effect                                                                                   |       | $        | (.03       | )        | $          | .04 |   |
| Cumulative effect                                                                                          |       | —   |       | —   |       |
|                                                                                                       |       | $        | (.03       | )        | $          | .04 |   |

 

The accompanyingnotes are an integral part of these statements.

2

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CONSOLIDATED STATEMENTSOF CASH FLOWS (Unaudited)

Three Months Ended July31,
| ** **                                                                                            | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Cash flows from  operating activities:                                                                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings (loss)                                                                                   |       | $          | (136,000   | )          | $          | 192,000 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by (used in) operating activities: |       |       |       |       |       |
| Gain on sale of real estate                                                                           |       | —     |       | (105,000   | )          |
| Gain on settlement of debt                                                                            |       | —     |       | (35,000    | )          |
| Impairment of real estate                                                                             |       | —     |       | 36,000     |       |
| Depreciation and amortization                                                                         |       | 28,000     |       | 33,000     |       |
| Change in value of stock appreciation rights                                                          |       | (14,000    | )          | (3,000     | )          |
| Increase (decrease) in cash flows from operations resulting  from changes in:                         |       |       |       |       |       |
| Accounts receivable                                                                                   |       | 174,000    |       | 81,000     |       |
| Inventories                                                                                           |       | 14,000     |       | (66,000    | )          |
| Prepaid expenses and other assets                                                                     |       | (45,000    | )          | (47,000    | )          |
| Trade accounts payable                                                                                |       | 96,000     |       | 62,000     |       |
| Accrued liabilities                                                                                   |       | 10,000     |       | 30,000     |       |
|                                                                                                  |       |       |       |       |       |
| Net cash  provided by operating activities                                                            |       | 127,000    |       | 178,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash flows from  investing activities:                                                                |       |       |       |       |       |
| Capital expenditures                                                                                  |       | (9,000     | )          | (16,000    | )          |
| Net proceeds from sale of asset                                                                       |       | —     |       | 205,000    |       |
|                                                                                                  |       |       |       |       |       |
| Net cash  provided by (used in) investing activities                                                  |       | (9,000     | )          | 189,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash flows from  financing activities:                                                                |       |       |       |       |       |
| Principal payments on long-term debt                                                                  |       | (18,000    | )          | (219,000   | )          |
|                                                                                                  |       |       |       |       |       |
| Net cash used in  financing activities                                                                |       | (18,000    | )          | (219,000   | )          |
|                                                                                                  |       |       |       |       |       |
| Net increase in  cash                                                                                 |       | 100,000    |       | 148,000    |       |
| Cash, beginning  of period                                                                            |       | 521,000    |       | 193,000    |       |
|                                                                                                  |       |       |       |       |       |
| Cash, end of period                                                                                   |       | $          | 621,000    |       | $          | 341,000 |   |
|                                                                                                  |       |       |       |       |       |
| Supplemental  Disclosures of Cash Flow Information                                                    |       |       |       |       |       |
| Cash paid during the period for:                                                                      |       |       |       |       |       |
| Interest                                                                                              |       | $          | 27,000     |       | $          | 33,000 |   |
| Income taxes  payable                                                                                 |       | $          | —     |       | $          | — |   |

 

The accompanyingnotes are an integral part of these statements.

3

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NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 - Basis ofPresentation

Torotelspecializes in the custom design and manufacture of a wide variety of precisionmagnetic components, consisting of transformers, inductors, reactors, chokesand toroidal coils, for use in commercial, industrial and militaryelectronics.  Torotel also designs anddistributes ballast transformers for the airline industry.  Approximately 95% of Torotel’s sales duringthe first three months of fiscal 2006 have been derived from domesticcustomers.  The accompanying unauditedconsolidated financial statements reflect the normal recurring adjustmentswhich in the opinion of management are necessary to present fairly Torotel’sfinancial position at July 31, 2006, and the results of operations for thethree months ended July 31, 2006.

Thefinancial statements contained herein should be read in conjunction withTorotel’s financial statements and related notes filed on Form 10-KSB for theyear ended April 30, 2006.

Note 2 -Inventories

The components ofinventories are summarized as follows:
| Raw materials   |   | $       | 76,000  |   |
|-----------------|--------|---------|---------|--------|
| Work in process |   | 169,000 |    |
| Finished goods  |   | 68,000  |    |
|            |   | $       | 313,000 |   |

 

Note 3 – FinancingAgreement

OnJune 25, 2006, Torotel Products refinanced its mortgage debt with the  Bank of Blue Valley.  Under the terms of the new financing, theoutstanding balance bears interest at a fixed rate of 8.0% per annum.  The note requires monthly principal andinterest payments of $9,947.  The note,which continues to be guaranteed by Torotel, Inc. and Electronika, Inc., has amaturity date of June 25, 2011 and is collateralized by a first mortgage on theland and buildings in Olathe, Kansas.  Asof July 31, 2006, the outstanding balance was $811,000.

Note 4 – Share-Based Compensation

EffectiveMay 1, 2006, Torotel adopted the fair value recognition provisions of Statementof Financial Accounting Standards No. 123 (revised 2004), “Share–Based Payment”(SFAS 123(R)) using the modified prospective method of adoption under theprovisions of SFAS No. 148, *Accounting forStock-Based Compensation – Transition and Disclosure*.  In accordance with the modified prospectivemethod, results for prior periods have not been restated.  Prior to May 1, 2006, Torotel accounted forall stock option grants under the provisions of APB Opinion 25, *Accounting for Stock Issued to Employees*and related interpretations; and accounted for all grants involving stockappreciation rights (SARs) under the provisions of SFAS 123 using the intrinsicvalue measurement guidelines of APB Opinion 25. The adoption of

4

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SFAS123(R) on existing stock option grants did not have any impact on our financialcondition or results of operations for the three months ended July 31, 2006;the adoption of SFAS 123(R) for the SARs resulted in a cumulative effectreduction in stock compensation costs of $8,000 for the same three-monthperiod.

Note 5 - EmployeeStock Options

Inaccordance with the Incentive Compensation Plan approved by shareholders in1994, Torotel reserved 400,000 common shares for issuance to key employeespursuant to the exercise of incentive stock options granted prior to June 20,2004.  The incentive stock options have aterm of five years when issued and vest 50% per year at the end of each of thefirst two years.  The exercise price ofeach option equaled the market price of Torotel’s common stock on the date ofgrant.  Accordingly, no compensation costwas recognized for the Plan at the time of grant, and no cost was incurred fromthe adoption of SFAS 123(R) as the outstanding options were fully vested in2004.

Thefair value of the incentive stock options granted was estimated on the date ofgrant using the Black-Scholes options-pricing model.  The fair value of the options was determinedusing the following weighted average assumptions: no dividend payments over thelife of the options; expected volatility of 551.0%; risk-free interest rate of3.50%; and expected life of five years.

Stockoption transactions under the 1994 Incentive Compensation Plan for each periodthrough July 31 are summarized as follows:
|                                                                 | ** ** | **2006**     | ** ** | **2005**     | ** ** |
|-----------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                      | ** ** | **Weighted** | ** ** | ** **   | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Shares**   | ** ** | **Average**  | ** ** | **Shares** | ** ** | **Average** | ** ** |
| ** **                                                      | ** ** | **Under**    | ** ** | **Exercise** | ** ** | **Under** | ** ** | **Exercise** | ** ** |
| ** **                                                      | ** ** | **Option**   | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period                             |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
| Granted                                                         |       | —       |       | —       |       | — |   | — |   |
| Exercised                                                       |       | —       |       | —       |       | — |   | — |   |
| Forfeited                                                       |       | —       |       | —       |       | — |   | — |   |
| Outstanding at  end of period                                   |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
|                                                            |       |         |       |         |       |   |   |   |   |
| Options  exercisable at end of period                           |       | 40,000       |       | $            | .37        |   | 40,000 |   | $ | .37 |   |
| Weighted average fair  value of options granted during the year |       |         |       | —       |       |   |   | — |   |

 

The followinginformation applies to options outstanding for each period through July 31:
|                                              | ** ** | **2006** | ** ** | **2005**  | ** ** |
|----------------------------------------------|------------|----------|------------|-----------|------------|
| Number  outstanding                          |       | 40,000   |       | 40,000    |       |
| Range of  exercise prices                    |       | $        | .37        |      | $          | .37 |   |
| Weighted average  exercise price             |       | $        | .37        |      | $          | .37 |   |
| Weighted average  remaining contractual life |       | .25 yrs. |       | 1.25 yrs. |       |

 

Note 6 –Restricted Stock Agreement

A Restricted Stock Agreement was entered into betweenTorotel and Benjamin E. Ames, Jr. effective July 31, 2006.  The agreement was authorized by theCompensation and Nominating Committee

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(Committee)and the Board of Directors of Torotel, as part of Mr. Ames’ employment asExecutive Vice President of Torotel Products, Inc., with primaryresponsibilities being new business development.  The Committee and the Board have determinedthat the interests of Torotel and its stockholders will be promoted by hiringtalented individuals and, to induce such individuals to accept employment withTorotel, the Committee and the Board believe a key component of suchindividuals’ compensation should be granting equity ownership opportunitiesbased upon the acceptance of employment and the continuing employment of suchindividual, subject to certain conditions and restrictions.  Mr. Ames is a recently hired key managementemployee.  The amount of the restrictedstock award was 200,000 shares of common stock, $.01 par value per share.  Based upon Mr. Ames attaining mutually agreedupon written annual goals, the restricted shares shall be released from therestrictions on transfer and risk of forfeiture in the amount of 40,000 sharesper year for five years beginning July 31, 2007, and each anniversarythereof.  The non-vested shares arerestricted as to disposition and subject to forfeiture under certaincircumstances.  The agreement providesMr. Ames with all voting rights with respect to the restricted shares.  The agreement further provides that if, priorto all of the restricted shares having been released, Torotel undergoes achange in control, then all of the restricted shares shall be released and nolonger subject to restrictions under the agreement.

Based on the market price of $.30 for Torotel’s commonstock as of July 31, 2006, the fair value of the restricted stock at the dateof award was $60,000.  Of this amount,$2,000 was credited to common stock at par value and the excess of $58,000 wascredited to additional paid-in capital. The restricted shares are treated as non-vested stock pursuant to SFAS123(R).  Accordingly, an offset amount,classified as unearned stock compensation, is included in the accompanyingconsolidated balance sheet under stockholders’ equity.  Stock compensation cost of $3,000 per quarterwill be recorded during the aggregate five-year vesting period provided themutually agreed upon goals are achieved.

Restrictedstock activity for the three months ended July 31 is summarized as follows:
|                                     | ** ** | **2006**     | ** ** |
|-------------------------------------|------------|--------------|------------|
| ** **                          | ** ** | **Weighted** | ** ** | **Weighted** | ** ** |
| ** **                          | ** ** | **Shares**   | ** ** | **Average** | ** ** |
| ** **                          | ** ** | **Under**    | ** ** | **Grant Date** | ** ** |
| ** **                          | ** ** | **Option**   | ** ** | **Value** | ** ** |
| Outstanding at  beginning of period |       | —       |       | — |   |
| Granted                             |       | 200,000      |       | $ | .30 |   |
| Vested                              |       | —       |       | — |   |
| Forfeited                           |       | —       |       | — |   |
| Outstanding at end of  period       |       | 200,000      |       | $ | .30 |   |

 

Note 7 -Stockholders’ Equity

The components ofstockholders’ equity are summarized as follows:
| Common stock, at par value      |   | $           | 54,000    |   |
|---------------------------------|--------|-------------|-----------|--------|
| Capital in  excess of par value |   | 12,420,000  |      |
| Unearned stock  compensation    |   | (60,000     | )         |
| Accumulated  deficit            |   | (10,935,000 | )         |
|                            |   | 1,479,000   |      |
| Less treasury  stock, at cost   |   | 205,000     |      |
|                            |   | $           | 1,274,000 |   |

 

6

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Thechanges in shares of common stock outstanding are summarized as follows:

| Balance, May 1, 2006      |   | 5,111,590 |   |
|---------------------------|--------|-----------|--------|
| Restricted stock activity |   | 200,000   |   |
| Treasury stock activity   |   | —    |   |
| Balance, July 31, 2006    |   | 5,311,590 |   |

 

Note 8 - EarningsPer Share

Statementof Financial Accounting Standards (SFAS) No. 128, *Earnings per Share*, requires dual presentation of basic anddiluted EPS on the face of the statement of earnings regardless of whetherbasic and diluted EPS are the same; and requires a reconciliation of thenumerator and denominator used in computing basic and diluted EPS.  Basic EPS excludes dilution and is computedby dividing earnings available to common stockholders by the weighted averagenumber of common shares outstanding for the  period. Diluted EPS is computed similarly to fully diluted EPS pursuant to APBOpinion 15.  Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted into common stock or resulted in theissuance of common stock that then shared in the earnings of the entity.  The 200,000 shares issued pursuant to theRestricted Stock Agreement (see Note 6 of Notes to Consolidated FinancialStatements) meet the definition of contingently issuable shares as outlined inSFAS No. 128; as a result, these shares will not be included in the basic EPScalculation until the performance measurements have been satisfied.  The restricted shares will be treated as acommon stock equivalent for the diluted EPS calculation.

Pursuantto SFAS No. 128, the basic and diluted earnings per common share were computedas follows:
|                                                                      | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| Earnings (loss)  before cumulative effect                            |       | $         | (144,000   | )         | $          | 192,000 |   |
| Cumulative  effect                                                   |       | 8,000     |       | —    |       |
| Net earnings  (loss)                                                 |       | $         | (136,000   | )         | $          | 192,000 |   |
|                                                                 |       |      |       |      |       |
| Weighted average  common shares outstanding for basic EPS            |       | 5,111,590 |       | 5,111,590 |       |
| Incremental  shares for effect of stock options and restricted stock |       | —    |       | —    |       |
| Weighted average  common shares outstanding for dilutive EPS         |       | 5,111,590 |       | 5,111,590 |       |
|                                                                 |       |      |       |      |       |
| Basic earnings  (loss) per share:                                    |       |      |       |      |       |
| Before cumulative effect                                             |       | $         | (.03       | )         | $          | .04 |   |
| Cumulative effect                                                    |       | —    |       | —    |       |
|                                                                 |       | $         | (.03       | )         | $          | .04 |   |
| Diluted earnings  (loss) per share:                                  |       |      |       |      |       |
| Before cumulative effect                                             |       | $         | (.03       | )         | $          | .04 |   |
| Cumulative effect                                                    |       | —    |       | —    |       |
|                                                                 |       | $         | (.03       | )         | $          | .04 |   |

 

Noincremental shares are included in the 2006 EPS calculations for the 40,000shares under option or the 200,000 shares of restricted common stock since theeffect would be anti-dilutive.  Therewere no anti-dilutive incremental shares in 2005 because the average marketprice of the common stock was less than the exercise price.

7

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Note9 – Stock Appreciation Rights

OnSeptember 10, 2004, the board of directors of Torotel approved the DirectorsStock Appreciation Rights Plan (the “Plan”) for non-employee directors.  Each SAR is equal to one share of commonstock of Torotel, and the aggregate number of SARs that may be granted underthe Plan shall not exceed 500,000. The effective date of the Plan is October 1,2004.  The SARs are now accounted forunder SFAS No. 123(R), *Accounting forStock-Based Compensation.*

Pursuantto the Plan, 20,000 SARs were granted on the effective date to each of thethree current non-employee directors. The initial price at which each SAR was granted was $.35, which equaledthe market price of Torotel’s common stock on the date of grant.  Accordingly, no compensation cost wasrecognized at the time of grant in accordance with APB Opinion 25, prior to theadoption of SFAS No. 123(R) on May 1, 2006, as discussed in Note 4 of Notes toConsolidated Financial Statements.

SARsshall automatically be granted in the future as follows: (1) each person who iselected as a director, who was not a director on the effective date of thePlan, shall be granted 10,000 SARs on the date such person is elected adirector; and (2) on each May 1 following the effective date during the term ofthe Plan, each person serving as a director on such date shall be granted10,000 SARs.  After the initial grant,the price at which each SAR is granted shall be the average of the closingprice of Torotel’s common stock for the ten consecutive days immediatelypreceding the date of grant.  Uponexercise of a SAR, Torotel will pay the grantee an amount (the “Spread”) equalto the excess of the Exercise Price over the SAR grant price multiplied by thenumber of shares being exercised.  TheExercise Price shall be the average of the closing price of Torotel’s commonstock for the ten consecutive days immediately preceding the notice ofexercise.  For any payments that exceed$10,000, Torotel has the option to make quarterly payments over three yearswith interest payable quarterly at the prime rate of Torotel’s primary bank.

Each SAR granted hereunder may be exercised to theextent that the Grantee is vested in such SAR. The SARs will vest according to the following schedule:
| Number of Years the Grantee has remained | ** ** | **Shares represented**               | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **a director of the Company following**       | ** ** | **by a SAR in which** | ** ** |
| **the Date of Grant**                                   | ** ** | **a Grantee is Vested**    | ** ** |
| Under one                                                              |       | 0                                         | %          |
| At least one but  less than two                                        |       | 33                                        | %          |
| At least two but  less than three                                      |       | 67                                        | %          |
| Three or more                                                          |       | 100                                       | %          |

##  

A Grantee shall become fully (100%)vested in each of his or her SARs under the following circumstances:  (i) upon termination of the Grantee’s serviceas a director of Torotel for reasons of death, disability or retirement; (ii)if the Compensation and Nominating Committee (the “Committee”), in its solediscretion, determines that acceleration of the SAR vesting schedule would bedesirable for Torotel; or (iii) if the Torotel shall, pursuant to action by itsBoard of Directors, at any time propose to merge into, consolidate with, orsell or otherwise transfer all or substantially all of its assets to anothercorporation, and provision is not made pursuant to the terms of suchtransaction for the assumption by the surviving, resulting or acquiring corporationof outstanding SARs or for substitution of new SARs therefore, the Committeeshall cause written notice of the proposed transaction to be given to eachGrantee not less than twenty days prior to the anticipated effective date ofthe proposed transaction, and his or her SARs shall become fully (100%) vestedand, prior to a date specified in such notice, which shall be not more than tendays prior to the anticipated effective date of the proposed transaction, eachGrantee shall have the right to exercise his or her SARs.

Inaccordance with SFAS 123(R), compensation expense is recognized over thevesting period based upon the estimated fair value of the SARs pursuant to theterms of the Plan using the Black-Scholes options-pricing

8

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model as of theend of each financial reporting period. As of July 31, 2006, the fair value of the SARs was determined using thefollowing assumptions: no dividend payments over the life of the SARs sinceTorotel has not issued any form of dividend since 1985; an expected volatilityof 181.24% based on Torotel’s historical volatility using the weekly closingprice over the past five years; a risk-free interest rate of 4.50%; and anexpected life of five years based on the length of service estimated to beserved.  Based on these assumptions, thefair value price per share of the outstanding SARs are summarized as follows:
| ** **          | ** ** | **SARs**   | ** ** | ** **   | ** ** | ** **          | ** ** | ** ** | ** ** | **Aggregate**       | ** ** | **Aggregate** | ** ** |
|---------------------|------------|------------|------------|--------------|------------|---------------------|------------|------------|------------|---------------------|------------|---------------|------------|
| ** **          | ** ** | **Under**  | ** ** | **Exercise** | ** ** | **Fair Value** | ** ** | **%**      | ** ** | **Vested**          | ** ** | **Intrinsic** | ** ** |
| **Grant Date** | ** ** | **Option** | ** ** | **Price**    | ** ** | **Price**           | ** ** | **Vested** | ** ** | **Fair Value** | ** ** | **Value**     | ** ** |
| October 1, 2004     |       | 60,000     |       | $            | .350       |                | $          | .597       |       | 33                  | %          | $             | 12,000     |   | $ | 16,000 |   |
| May 1, 2005         |       | 30,000     |       | $            | .302       |                | $          | .599       |       | 33                  | %          | $             | 6,000      |   | $ | 9,000 |   |
| May 1, 2006         |       | 30,000     |       | $            | .695       |                | $          | .590       |       | 0                   | %          | $             | —     |   | $ | — |   |

 

The vested portionrepresents 29,700 SARs.  As of July 31,2006, the total aggregate intrinsic value of these exercisable SARs was $8,000.

SARstransactions for each period though July 31 are summarized as follows:
|                                                                | ** ** | **2006**   | ** ** | **2005**     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                     | ** ** | **SARs**   | ** ** | **Average**  | ** ** | **SARs** | ** ** | **Average** | ** ** |
| ** **                                                     | ** ** | **Under**  | ** ** | **Grant**    | ** ** | **Under** | ** ** | **Grant** | ** ** |
| ** **                                                     | ** ** | **Option** | ** ** | **Price**    | ** ** | **Option** | ** ** | **Price** | ** ** |
| Outstanding at  beginning of period                            |       | 90,000     |       | $            | .334       |   | 60,000 |   | $ | .350 |   |
| Granted                                                        |       | 30,000     |       | $            | .695       |   | 30,000 |   | $ | .302 |   |
| Exercised                                                      |       | —     |       | —       |       | — |   | — |   |
| Forfeited                                                      |       | —     |       | —       |       | — |   | — |   |
| Outstanding at  end of period                                  |       | 120,000    |       | $            | .424       |   | 90,000 |   | $ | .334 |   |
|                                                           |       |       |       |         |       |   |   |   |   |
| SARs exercisable  at end of period                             |       | 29,700     |       | $            | .334       |   | — |   | — |   |
| Weighted average fair  value of SARs granted during the period |       |       |       | $            | .590       |   |   |   | — |   |

 

The followinginformation applies to SARs outstanding for each period through July 31:
|                                              | ** ** | **2006**      | ** ** | **2005**      | ** ** |
|----------------------------------------------|------------|---------------|------------|---------------|------------|
| Number  outstanding                          |       | 120,000       |       | 90,000        |       |
| Range of grant  prices                       |       | $.302 - $.695 |       | $.302 - $.350 |       |
| Weighted average  grant price                |       | $.424         |       | $.334         |       |
| Weighted average  remaining contractual life |       | 8.71 yrs.     |       | 9.36 yrs.     |       |

 

Total compensationexpense for the outstanding SARs for the three months ended July 31, 2006 and2005, was a reduction of $15,000 and $3,000, respectively.  The reduction of $15,000 in 2006 included$8,000 for the cumulative effect of adopting SFAS No. 123(R).  As of July 31, 2006, there was $54,000 oftotal unrecognized compensation expense related to non–vested SARs grantedunder the Plan.  That cost is expected tobe recognized over a weighted average period of 1.71 years.  The liability for SARs on the consolidatedbalance sheet as of July 31, 2006, was $18,000. The following table summarizes the pro forma effect if compensation costfor the Plan had been determined applying the fair value based method to alloutstanding SARs in each period presented:

9

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|                                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net earnings (loss)                                                                      |       | $        | (136,000   | )        | $          | 192,000 |   |
|                                                                                     |       |     |       |     |       |
| Add:  Stock-based  compensation income included in reported net earnings (loss)     |       | (15,000  | )          | (3,000   | )          |
|                                                                                     |       |     |       |     |       |
| Deduct:  Stock-based  compensation expense determined under fair value based method |       | 15,000   |       | —   |       |
|                                                                                     |       |     |       |     |       |
| Pro forma net earnings  (loss)                                                           |       | $        | (136,000   | )        | $          | 189,000 |   |
|                                                                                     |       |     |       |     |       |
| Basic earnings (loss)  per share:                                                        |       |     |       |     |       |
| as reported                                                                              |       | $        | (.03       | )        | $          | .04 |   |
|                                                                                     |       |     |       |     |       |
| pro forma                                                                                |       | $        | (.03       | )        | $          | .04 |   |
|                                                                                     |       |     |       |     |       |
| Diluted earnings (loss)  per share:                                                      |       |     |       |     |       |
| as reported                                                                              |       | $        | (.03       | )        | $          | .04 |   |
|                                                                                     |       |     |       |     |       |
| pro forma                                                                                |       | $        | (.03       | )        | $          | .04 |   |

 

Note 10 - Amortization of Intangibles

Sincethe acquisition of Electronika primarily involved the purchase of certaintechnology-based intangible assets, annual reviews have been performed todetermine the amount of any impairment. The remaining carrying value of these intangible assets is estimated at$684,000 and is supported by the projected amount recoverable from the sellingshareholders of Electronika (the Caloyeras Family Partnership).  The selling shareholders contractuallyguaranteed that the aggregate sales from Electronika’s existing ballast designsover the first five (5) full fiscal years, specifically fiscal years 2003-2007,would be at least $2,500,000, which based on the terms of the ManufacturingAgreement with Magnetika, Inc., would result in an aggregate gross profit of$1,500,000 before any operating expenses. Aggregate sales since fiscal 2003 have been $1,308,000, whichcontractually results in an amount due from the Caloyeras Family Partnership of$715,000 as of July 31, 2006.

Thefollowing table provides the adjusted gross carrying value and accumulatedamortization for each major class of intangible asset based on Torotel’sreassessment of previously recognized intangible assets in accordance with theadoption of Statement of Financial Accounting Standards No. 142, *Goodwill and Other Intangible Assets*:
|                      | ** ** | ** **      | ** ** | **2006**     | ** ** | **2005**         | ** ** |
|----------------------|------------|-----------------|------------|--------------|------------|------------------|------------|
| ** **           | ** ** | **Average**     | ** ** | **Gross**    | ** ** | ** **       | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **           | ** ** | **Amortizable** | ** ** | **Carrying** | ** ** | **Accumulated**  | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** |
| ** **           | ** ** | **Life**        | ** ** | **Amount**   | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Aircraft -  ballasts |       | 3               |       | $            | 1,148,000  |             | $          | 464,000 |   | $ | 1,148,000 |   | $ | 394,000 |   |
|                      |            |                 |            |              |            |                  |            |  |  |  |  |  |  |  |  |

 

Thetotal intangible amortization expense for the three months ended July 31, 2006and 2005 was $7,000 and $16,000, respectively. The estimated aggregate amortization expense for fiscal 2007 is asfollows:
| April 30, | ** ** | **Amount** | ** ** |
|----------------|------------|------------|------------|
| 2007           |       | 28,000     |       |
|           |       | $          | 28,000     |   |
|                |            |            |            |  |

 

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The remaining book value of approximately$663,000 at April 30, 2007, represents the projected amount recoverable fromthe former shareholders, and is based on the estimated sales from theaforementioned ballast designs.  Therecoverable amount will reduce the $750,000 note payable to shareholders, whoare also the owners of Magnetika.

Note 11 – Concentrations of Credit Risk

At various times and at July 31, 2006,Torotel maintained cash in bank balances that exceed the federally insuredlimits.

11

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Item 2.    Management’s Discussion and Analysis or Planof Operation

 

Overview

Torotel, Inc. (“Torotel”)conducts business primarily through two wholly owned subsidiaries, TorotelProducts, Inc. (“Torotel Products”) and Electronika, Inc. (“Electronika”).  In addition, Torotel has a 12.88% equityinterest in Apex Innovations, Inc. (“Apex”).

Torotel Products designsand manufactures a wide variety of magnetic components for use in military,aerospace and industrial electronic applications.  These magnetic components, which consist oftransformers, inductors, reactors, chokes, and toroidal coils, are used tomodify and control electrical voltages and currents in electronic devices.  For example, if equipment containing one ofthese components receives an electrical voltage or current which is too highfor proper operation of the equipment, the component would modify and controlthe electrical voltage or current to allow proper operation of theequipment.  While Torotel Productsprimarily manufactures the components in accordance with pre-developedmechanical and electrical requirements, in some cases it will be responsiblefor both the overall design and manufacture of the components.  The magnetic components are sold tomanufacturers who incorporate them into an end product.  The major applications include aircraftnavigational equipment, voice and data secure communications, medicalequipment, avionics equipment, and conventional missile guidance systems.  As part of its long-term strategy, TorotelProducts has started to include electro-mechanical sub-assemblies as part ofits product base.

Torotel Products marketsits components primarily through a 4-person internal sales force, whichincludes a recently hired Executive Vice President in charge of new businessdevelopment, and three independent manufacturers’ representatives paid on acommission basis.  Torotel Products alsohas a 4-person engineering department that is active in the sales and marketingefforts.  An incentive program has beendeveloped in this regard for all engineering personnel to earn a commission onnew product sales to existing, as well as new customers.

Torotel Products is anapproved source for magnetic components used in numerous military and aerospacesystems, which means Torotel Products is automatically solicited for anyprocurement needs for such applications. The magnetic components manufactured by Torotel Products are soldprimarily in the United States, and most sales are awarded on a competitive bidbasis.  The markets in which TorotelProducts competes are highly competitive. A substantial number of companies sell components of the typemanufactured and sold by Torotel Products. In addition, Torotel Products sells to a number of customers who havethe capability of manufacturing their own electronic components.  The principal methods of competition forelectronic products in the markets served by Torotel Products include, amongother factors, price, on-time delivery performance, lead times, customized productengineering and technical support, marketing capabilities, quality assurance,manufacturing efficiency, and existing relationships with customers’engineers.  While magnetic components arenot susceptible to rapid technological change, Torotel Products’ sales, whichdo not represent a significant share of the industry’s market, are susceptibleto decline given the highly competitive nature of the market.

Electronika is amarketing and licensing company selling ballast transformers to the airlineindustry.  These transformers activateand control the lights in commercial airplane cockpits.  Electronika’s ballast transformers areapproved as spare and replacement parts in DC-8, DC-9, DC-10, MD-80, and MD-88aircraft.  However, sales of ballasttransformers have been made primarily for use in DC-8 and DC-9

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aircraft. As a result, the business of Electronika is subject to various risksincluding, without limitation, any decline in use of the referenced aircraft,and competition for the available spare parts business.  Electronika’s sales do not represent asignificant portion of any particular market. Electronika’s requirements for the ballast transformers are outsourcedpursuant to a Manufacturing Agreement with Magnetika, Inc. (“Magnetika”), acorporation owned by Peter B. Caloyeras and his family.  Mr. Caloyeras and his son, Basil P. Caloyeras(president of Electronika) also serve as directors of Electronika.  Under the terms of the agreement, Magnetikaprovides all necessary raw material, labor, testing, packaging and relatedservices required to complete the manufacture, delivery and sale of the ballasttransformers.  Electronika retainsownership of all designs, drawings, specifications and intellectual propertyrights associated with the ballast transformers.  Due to lower than anticipated sales forElectronika, the carrying value of the intangible assets of Electronika is now$684,000.  These intangible assets arebeing partially amortized in fiscal 2007. At April 30, 2007, the remaining value of the intangible assets isexpected to be approximately $663,000, which will represent the projectedamount recoverable pursuant to the sales guarantee provided by the sellingshareholders of Electronika.  Therecoverable amount will reduce the $750,000 note payable to shareholders, whoare also the owners of Magnetika. Magnetika is a manufacturing company that, in addition to theaforementioned ballast transformers, manufacturers various other productssimilar to those of Torotel for other unrelated customers.  Magnetika’s annual sales are estimated to beapproximately two to three times the annual sales of Torotel.  Total purchases from Magnetika by Electronikaamounted to $9,000 for the three months ended July 31, 2006.

Business Outlook

Torotel Products’ industry mix for fiscal 2006 net sales was 52% defense, 32% aerospace and 16% commercial/industrial.  The mix for the first quarter sales of fiscal 2007 was 43% defense, 37% aerospace and 20% commercial/industrial.  This shift toward aerospace and commercial/industrial follows the trend expected for fiscal 2007.  New order bookings for fiscal 2007 were projected to increase 12% primarily due to new opportunities in the aerospace market, higher order rates of the new capacitor assemblies in the second half of fiscal 2007, and a major commercial contract award that was expected near the end of the first quarter of fiscal 2007.  New order bookings for the first quarter increased nearly 17%, which included a $2.1 million contract for the potted coil assembly for the Hellfire II missile system.  The timing of the major commercial contract award that was originally expected in July 2006 has been delayed, but receipt of the order is expected within the next 60 days.  It is anticipated that this contract will contribute to higher shipments in the latter part of fiscal 2007.  The order backlog at July 31, 2006 is $3,696,000, a 27% increase from a year ago.  The primary factors that drive gross profit and net earnings for Torotel Products are sales volume and product mix.  The gross profits on mature products/programs and larger transformer devices tend to be higher than those that are still in the prototyping or early production stages and simpler inductor devices.  As a result, in any given accounting period the mix of product shipments between higher and lower margin jobs has a significant impact on the gross profit and net earnings of Torotel Products.

As disclosed in Torotel’s Form 10-KSB for the fiscal year ended April 30, 2006, Torotel’s operating plan calls for additional sales and marketing costs in the form of personnel, advertising, trade show exhibits and new print literature.  Management believes a well developed growth strategy is in place and that these expenditures are critical for achieving that growth; as a result, near-term earnings may be impacted. 

Torotel’s management will continue to focus its efforts in areas and solutions that offer significant growth, which includes expanding the product base beyond electronic components.  The aircraft manufacturers

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continue to book orders at a record pace with substantial backlog through at least the end of the decade; Torotel will continue to expand its sales and marketing efforts in this area.  Fiscal 2006 brought some success in the assembly of electro-mechanical solutions and cables; Torotel management sees this as a strong growth area in the future.  Management’s goal, “9-by-9”, is to reach a revenue level of $9 million by fiscal year 2009.

Electronika’s net sales continue to be impacted by the decline in the number of active DC-8 and DC-9 aircraft.  Management expects these sales to continue to decline and eventually bottom out.

Results ofOperations

Thefollowing management comments regarding Torotel’s results of operations andoutlook should be read in conjunction with the Consolidated Financial Statementsincluded pursuant to Item 1 of this Quarterly Report.

Thediscussion and analysis of the results of operations include the operations ofTorotel, Inc. and its subsidiaries, Torotel Products, Inc. and Electronika,Inc.  While each company’s results areincluded in the following discussion, segment reporting is not applicablebecause the products offered are similar in form and function, and targetsimilar markets.

Three Months Ended July31, 2006 Compared With Three Months Ended July 31, 2005

Net sales decreased 5%.  The net sales of Torotel Products decreased nearly 4% from $1,219,000 to $1,175,000.  This decrease is attributable to lower sales of components used on the AMRAAM, Hellfire II and Maverick missile systems.  This decrease was partially offset by higher shipments of the potted coil assembly for the Hellfire II missile system.  The net sales of Electronika decreased 50% from $48,000 to $24,000, which is representative of the downward trend in Electronika’ sales.

Grossprofit as a percentage of net sales decreased 10%.  The gross profit percentage of TorotelProducts decreased 10% because of lower sales volume, higher fixed productioncosts due to the hiring of a production and quality assurance technician, andhigher absorption of labor and overhead costs due to a decrease in the level ofwork in process inventory as part of the ongoing efforts to implement DemandFlow Technology® and reduce average production cycle times.  Electronika’s gross profit as a percentage ofnet sales remained unchanged.

Engineeringexpenses, applicable only to Torotel Products, increased 12% from $57,000 to $64,000because of higher payroll costs associated with two college interns utilizedduring the summer months and additional travel costs.  Management does anticipate an increase in thepresent level of engineering expenses as additional engineering technicalsupport is planned.

Selling,general and administrative (SG&A) expenses increased 26%.  The SG&A expenses of Torotel, Inc.increased 53% from $73,000 to $112,000 primarily because of a $24,000 increasein  professional fees associated with thechange in control tactics being attempted by the Caloyeras Family Partnership,a $15,000 increase in auditing fees and a $5,000 increase in directors feesassociated with special board meetings called to address the matters initiatedby the Caloyeras Family Partnership. These increases were offset partially by a $5,000 decrease in the costsof preparing electronic filings to the SEC. The SG&A expenses of Torotel Products increased nearly 19% from$275,000 to $326,000 primarily because of a $15,000 increase in marketing andadvertising costs, a $13,000 increase in payroll costs, a $9,000 increase inequipment maintenance costs, an $8,000 increase in training costs and a $6,000increase in bank charges

14

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associatedwith the write-off of capitalized loan fees on the original mortgage loan forthe Olathe facility (see Note 3 of Notes to Consolidated FinancialStatements).  The SG&A expenses ofElectronika remained unchanged at $8,000. Management does anticipate an increase in the present level of SG&Aexpenses as the plan calls for additional sales and marketing costs in the formof personnel, advertising, trade show exhibits and new print literature.

Amortizationcosts, entirely attributable to Electronika, decreased 56% from $16,000 to$7,000 (see Note 10 of Notes to Consolidated Financial Statements).

Interestexpense decreased 18%.  The interestexpense of Torotel, Inc. remained unchanged at $13,000.  The interest expense of Torotel Productsdecreased from $20,000 to $14,000 because of a lower debt balance.

Interest incomeincreased $2,000 because of funds set aside in a money management account.

Therewas no earnings impact in the current quarter from an impairment of realestate.  A charge of $36,000 was recordedin the prior year.

Therewas no earnings impact in the current quarter from a gain on the settlement ofdebt.  A gain of $35,000 was recorded inthe prior year.

Therewas no earnings impact in the current quarter from a gain on the sale of realestate.  A gain of $105,000 was recordedin the prior year.

Forthe reasons discussed above, the consolidated pretax earnings decreased from aprofit of $192,000 to a loss of $144,000. The pretax loss of Torotel, Inc. increased from $51,000 to$125,000.  The pretax earnings of TorotelProducts decreased from a profit of $237,000 to a loss of $20,000.  The pretax earnings of Electronika decreased from$6,000 to $1,000.

Liquidity andCapital Resources

As of July 31, 2006, Torotelhad $621,000 in cash and cash equivalents, compared to $341,000 as of July 31,2005.  Effective June 25, 2006, Torotelrefinanced its mortgage debt with the Bank of Blue Valley with a new maturitydate of June 25, 2011 (see Note 3 of Notes to Consolidated FinancialStatements).  The $750,000 note payableto shareholders matures in March 2007 (see Note 10 of Notes to ConsolidatedFinancial Statements).  Torotel intendsto offset this debt by the amount recoverable pursuant to the sales guaranteeprovided by the selling shareholders of Electronika.  At April 30, 2007, the projected amountrecoverable is $663,000.  The projecteddifference of $87,000 after the offset will be paid from existing cashresources.

The table below presents the summary of cash flow for the three-month periods indicated.

|                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Net cash provided by  operating activities           |       | $        | 127,000    |     | $          | 178,000 |   |
| Net cash provided by  (used in) investing activities |       | $        | (9,000     | )        | $          | 189,000 |   |
| Net cash used in financing activities                |       | $        | (18,000    | )        | $          | (219,000 | ) |

 

Netcash provided by operating activities fluctuates between periods primarily as aresult of differences in operating earnings, the timing of shipments and thecollection of accounts receivable, changes in inventory, level of sales andpayment of accounts payable.  Thedecrease in net cash provided by investing activities is because of the netproceeds of $205,000 from the sale of the real estate in 2005.  Capital expenditures were $9,000 during thefirst three months of fiscal 2007. Management anticipates

15

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approximately$100,000 in total capital expenditures for fiscal 2007.  Net cash used in financing activities isbecause of payments on long-term debt. Management believes that the projected cash flow from operations,combined with its existing cash balances, will be sufficient to meet itsfunding requirements for the foreseeable future.  Torotel does have a $200,000 bank line ofcredit available, which could be utilized, if required, to help fund growth.

Managementbelieves that inflation will have only a minimal effect on future operationssince such effects will be offset by sales price increases, which are notexpected to have a significant effect upon demand*.*

Torotel’sboard of directors has determined that Return on Capital Employed (“ROCE”) willbe the primary tool for managing Torotel’s business.  ROCE is measured by the following formula:
| **Earnings before interest and taxes (EBIT)**         | ** ** | **X**      | **Net  Sales**                                                    | **=**      | **ROCE**   |
|-------------------------------------------------------|------------|------------|-------------------------------------------------------------------|------------|------------|
| **Net  Sales**                                        | ** ** | ** ** | **Net  Operating Assets (NOA)**                                   | ** ** | ** ** |
| ** **                                            | ** ** | ** ** | ** **                                                        | ** ** | ** ** |
| **Measures profit and loss management**               | ** ** | ** ** | **Measures balance sheet management**                             |
| ** **                                            | ** ** | ** ** | ** **                                                        |
| **Profitability %**                                   | ** ** | ** ** | **Activity rating**                                               |
| ** **                                            | ** ** | ** ** | ** **                                                        |
| **Measures how much profit in each  dollar of sales** | ** ** | ** ** | **Measures how much sales is  generated from each dollar of NOA** |
| ** **                                            | ** ** | ** ** | ** **                                                        |
| **Quality of Revenue**                                | ** ** | ** ** | **Quantity of Revenue**                                           |

 

ROCE measures whatyou get out (EBIT) versus what you put in (NOA = Capital Employed).  For these purposes, NOA is defined as “accountsreceivable + inventory + net fixed assets + miscellaneous operating assets –accounts payable – miscellaneous operating liabilities”.  The performance of Torotel’s management andthe majority of its decisions going forward will be measured by whether Torotel’sROCE improves.  In fiscal 2004, 2005 and2006, Torotel’s ROCE was 1.46%, 5.84% and 19.04%, respectively.  Torotel’s ROCE for the 12-month trailingperiod ended July 31, 2006 is 10.84%, which is not indicative of theexpectations for the balance of fiscal 2007.

Forward-LookingInformation

Thisreport, as well as our other reports filed with the Securities and ExchangeCommission (“SEC”), and in press releases and other public communicationsthroughout the year, contains forward looking statements made pursuant to thesafe harbor provisions of The Private Securities Litigation Reform Act of1995.  The words “believe,” “estimate,” “anticipate,”“project,” “intend,” “expect,” “plan,” “outlook,” “forecast,” “may,” “will,” “should,”“continue,” “predict” and similar expressions are intended to identify forwardlooking statements.  This report containsforward looking statements regarding, among other topics, our expectedfinancial position, results of operations, cash flows, strategy, budgets andmanagement’s plans and objectives. Accordingly, these forward-looking statements are based on assumptionsabout a number of important factors. While we believe that our assumptions about such factors are reasonable,such factors involve risks and uncertainties that could cause actual results tobe different from what appear here. These risk factors include: the ability to adequately pass through tocustomers unanticipated future increases in raw material costs, decreaseddemand for products, delays in

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developingnew products, expected orders that do not occur, loss of key customers, theimpact of competition and price erosion as well as supply and manufacturingconstraints, and other risks and uncertainties. In light of these risks and uncertainties, there can be no assurancethat the forward-looking information contained in this report will prove accurate,and our actual results may differ materially from these forward lookingstatements.  We assume no obligation toupdate any forward-looking statements made herein.

Item 3.    Controls and Procedures

Torotel’sChief Executive Officer and Chief Financial Officer (collectively, the “CertifyingOfficers”) are responsible for establishing and maintaining disclosure controlsand procedures (as defined in Exchange Act Rule 13a-15(e)) for Torotel.  Such officers have concluded (based upontheir evaluation of these controls and procedures as of a date within 90 daysof the filing of this report) that Torotel’s disclosure controls and proceduresare adequate and effective for purposes of Rule 13a-14(c) in timely alertingthem to material information relating to Torotel required to be included inTorotel’s filings with the SEC under the Securities Exchange Act of 1934.  The Certifying Officers also have indicatedthat there were no changes during the period covered by this report in Torotel’sinternal controls over financial reporting or other factors that havematerially affected, or are reasonably likely to materially affect suchcontrols, and there were no corrective actions with regard to significantdeficiencies and material weaknesses.

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PART II.    OTHER INFORMATION

Item 6.   Exhibits and Reports on Form 8-K
| a)   Exhibits            |   |                                                                                                                     |
|------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------|
|                               |   |                                                                                                                     |
| Exhibit 31.1                       |   | Officer Certification                                                                                                    |
| Exhibit 31.2                       |   | Officer Certification                                                                                                    |
| Exhibit 32.1                       |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
| Exhibit 32.2                       |   | Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 |
|                               |   |                                                                                                                     |
| b)   Reports on Form 8-K |   | There was one  report filed on Form 8-K during the three months ended July 31, 2006.                                     |
|                                    |        |                                                                                                                          |  |  |

 

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SIGNATURES

Inaccordance with the requirements of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Torotel,  Inc.                        |
|---------------------------------------|
| (Registrant)                          |
|                                  |
|                                  |
| /s/  Dale H.  Sizemore, Jr.      |   |
| Dale H. Sizemore, Jr.                 |
| Chief Executive Officer               |
| Date:    September 12, 2006 |
|                                  |
|                                  |
| /s/  H. James  Serrone           |   |
| H. James Serrone                      |
| Chief Financial Officer               |
| Date:    September 12, 2006 |

 

19

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